Risk-adjusted return on capital (RAROC) is a target return on equity (ROE) measure in which the numerator is reduced depending on the risk associated with the instrument or project. In insurance industry, RAROC is the expected net income divided by economic capital. It is typically employed to evaluate the relative performance of business segments that have different levels of solvency risks; the different levels of solvency risk are reflected in the denominator.
Evaluating financial performance under RAROC calls for comparison to a benchmark return; when the benchmark return is risk-adjusted (e.g., for volatility in net income), the result is similar to risk-adjusted return on risk-adjusted capital (RARORAC), though the term RAROC is still applied. [Source: Casualty Actuarial Society (CAS) Overview of Enterprise Risk Management]
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